China’s economy has lost momentum after a surprisingly strong start to the year.
But while many analysts are asking why Beijing isn’t doing more to stimulate growth, this week’s Trivium China Podcast explores a different question: why are policymakers deliberately choosing not to?
Pod host Andrew Polk is joined by Trivium’s Head of Markets Research Dinny McMahon to examine why Beijing may be quietly embarking on its first genuine economy-wide deleveraging effort in years, and what that could mean for China’s growth model.
The two discuss:
Why recent weakness in investment, consumption, and the property sector won’t trigger a major stimulus package
Whether Beijing’s annual fiscal “stimulus” has become more theater than meaningful economic support
How slowing credit growth could signal a deliberate shift in macroeconomic strategy
Why strong exports and rising inflation may have created a rare opportunity to reduce leverage
Why policymakers appear to be prioritizing future borrowing capacity over stronger short-term growth
Andrew and Dinny also explore what slower credit growth means for businesses and investors and how Beijing’s evolving priorities could complicate trade negotiations with Europe and other major trade partners.
Transcript
Andrew Polk: Hi, everybody, and welcome to the latest Trivium China Podcast, a proud member of the Sinica Podcast Network. I’m your host, Trivium Co-Founder, Andrew Polk, and I’m joined today by Trivium’s Head of Markets Research, Dinny McMahon. Dinny, great to have you back on the pod. How are you doing, brother?
Dinny McMahon: Doing good, mate. Great, as always, to be here.
Andrew: Yeah, it’s been a couple of weeks since we’ve had a podcast. So, I was on vacation with my in Hawaii. Nice to get away. Come back to the very, very hot DC weather, although it’s cooling off a bit now, but I’m glad to be back in the groove and glad to have a fan favorite here, Dinny, to kick off the second half of the year with me. We are going to talk, of course, about the Chinese economy. And specifically, we’re going to talk about what’s happening with credit growth in the economy, which may sound, I don’t know, wonky, but it’s hugely important to the overall trajectory and pace of growth in the Chinese economy.
And it’s traditionally how the Chinese policymakers either stimulate growth or sort of pull back on growth rather than using the monetary lever per se. It’s really more of the credit impulse. That, of course, has changed more towards a fiscal impulse in the past, say, four or five years. But credit growth is hugely still important to the, like I said, the overall management of the economy, the trajectory of the economy. Dinny has some really unique, and I think… well, I mean, unique in a good way, like out of consensus views on what’s-
Dinny: Sounds like unique and courageous.
Andrew: Yeah, yeah, yeah. Shall we say unique views? No, I think really thoughtful views on what’s happening here, how credit policy relates to overall macroeconomic growth, and kind of what that means around economic performance in the second half of the year. So we’re going to get into all of that. And it’s going to be an exciting conversation.
But of course, before we do that, got to start with the customary vibe check. Dinny, it’s July 9th, 3.20 pm in the afternoon Eastern time. And you are recording from the Eastern time zone, which is not normally the case. You used to be in the Central Time Zone. How’s your vibe? Welcome to the East Coast.
Dinny: Mate, I mean, look, no shade on Chicago. I was there for nine years, and I love the city. But dude, North Carolina is doing good things for my vibe. I mean, no one can see this. We’d hope to record this, but we haven’t kind of got our act together yet. But like my back window opens onto a forest. I mean, I’m loving the warmth. I’m loving the humidity. I’m loving the greenery. This place is doing some good things for my soul. So, I might still be in the honeymoon period, but I’m doing great, mate.
Andrew: Well, that’s great to hear, dude. I’m glad you like it down there. And a chilled Dinny is a happy Dinny is a happy Trivium is a happy Andrew. So, I love it. And you can bring your chilled but still intensely thoughtful vibes to the podcast. And I, meanwhile, super rested, had a couple of good weeks off with the family, just no work, all relaxation. So ready to get back to it, second half of the year. I had a good night out with a handful of my China nerd friends last night in D.C., which was good to catch up with people.
So, I’m ready to get back to it. That’s my vibe is raring to go. So, with that out of the way, we also have to quickly do the housekeeping up top. Just firstly, a quick reminder, we’re not just a podcast here. Trivium China is a strategic advisory firm that helps businesses and investors navigate the China policy landscape. That, of course, includes domestic policy in China in a range of areas — autos, tech, macro, econ, as we’re going to talk about today, commodities — you name it, we do it.
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All right. With that out of the way, Dinny, we are going to get into the latest on the macroeconomic front, and specifically what’s happening with credit growth and the credit environment, I think we can sort of safely say that after a really good start to the year, the past few months, so really Q2 have been pretty terrible for China’s economy. Fixed asset investment. So overall kind of capex in the economy fell 12.5% year over year in May. So negative growth, actually significant contraction of 12.5% year over year. Last month, May is the most recent data we have. That was a sharper contraction than April’s 9.4% decline. So, not only is the economy weak, it seems to be weakening. And one of the key issues is that deterioration is broad-based.
So, it’s manufacturing investment down 4%, infrastructure down 9.5%. And the property sector, where we had been sort of hopeful that the worst was over, even it took a pretty clear return for the worst in May with new home sales by floor space falling about 12%. That was down from the 9% year-over-year drop in April. So, just kind of across the board looking terrible. On the retail\consumer side of things, the dynamics are just as bad. Auto sales down 16% year-over-year last month. Home appliances sales down about 16%, furniture down 9%, even mobile phone sales, which people replace pretty regularly, and which had been holding up in recent months, they just eked out 0.7% year-over-year growth.
So, pretty terrible profile after a good start to the year, but it all sort of raises the question, why aren’t policymakers doing more to support or stimulate the economy? And I know you’ve got a lot of thoughts on this, specifically, as I said, when it comes to the credit side of things. So, Dinny, I’ll just throw it over to you. Can we expect more support, lay the land on kind of what you’re thinking here in terms of what policymakers’ approach is?
Dinny: Well, I think the real question isn’t exactly support because, I mean, we’ve held the position for ages that interest rate cuts aren’t coming. I mean, monetary policy isn’t really in the toolkit at the moment in terms of sort of dealing with economic weakness. They’ll tweak here and there, but that’s not really what’s going on. The question is, are we going to see stimulus, straight up fiscal stimulus? And I think the answer is yes and no. So, every year for the last few years, in the last few months of the years, we’ve got some sort of stimulus.
So, what we had last year in October was an extra 500 billion RMB worth of special purpose bonds for local governments to issue. And some of that had to go into infrastructure. And some of that was just broad fiscal support to help local governments with their budgets. Some of it was for paying down arrears. And I think it’s likely we’ll get something like that again, probably around 500 billion again. The question is, though, should we consider that as being stimulus? Now, what I mean by that is that last year, local governments were permitted to issue 4.9 trillion RMB worth of special purpose bonds, And that was broken up into a 4.5 trillion RMB quota that they got in March at the legislative session, the government work report.
And then they got that additional 500 billion at the end of the year I was talking about. Now, this year, they got the same 4.4 trillion quota in March. So, we could get an additional 500 billion top up by the end of the year. And that would be the same as last year’s total. So, the question then becomes, is that stimulus or is that just the bare minimum necessary to maintain economic activity at last year’s level, right? For local governments just to be spending as much as they did in 2025, do you need an additional 500 billion RMB? And I think in this economic environment, the answer is probably yes.
So, it’s also, the other question here in addition to that is, is it stimulus if the government’s doing the same thing every year, if it’s providing that same top-up on government spending in October every year? Which is what it’s been doing. To me, that doesn’t strike me as stimulus. That strikes me as state management, right? They kind of lay the expectations earlier at the beginning of the year. We’re going to let government borrow this much. And then, lo and behold, everybody chill. We’re going to provide stimulus in the last few months of the year.
But if they’re doing that every year on a comparable amount, that doesn’t really feel like stimulus. That kind of feels like drum roll, please, everybody. Everybody chill. There’s more stimulus. Everybody be cool. It feels like smoke and mirrors as opposed to a real injection into the economy. And I think that’s particularly pertinent this year because I don’t think we should be watching the stimulus because I think it is smoke and mirrors.
I think what we need to be watching is what happens with total social financing, which is the government’s measure of the total amount of credit being put into the economy. Because I think what’s happening this year is that Beijing is striving to start deleveraging. So, regardless of whether we get stimulus, the amount of credit being pumped into the economy this year, I think is likely to fall pretty significantly. And what Beijing is trying to embark on is a conscious effort to start deleveraging the economy.
Andrew: Okay, well, so you’ve broken it out well. It’s a good point around if stimulus is every year, is it truly stimulus, right? Or is that just the new baseline? I mean, I’m trying to go back to my economics 101, macro 101, a permanent expansion in aggregate demand versus a temporary expansion in aggregate demand via fiscal stimulus. Very Keynesian idea. And the short-term stimulus tends to have more of a policy effect, whereas longer-term perpetual stimulus, typically prices just adjust, right? And people adjust to this new level without really seeing it as a way to kind of boost their short-term economic prospects.
So, without getting way too into that, and I’m sure someone will call me out on that. I’m sure I got part of that wrong. But point being, if it’s permanent, people and businesses, which matter ultimately in the economy, think about it differently. And it doesn’t really provide that stimulatory effect exactly that you’re talking about. On the credit side, which is so important, I want you to get into that a little bit more. The last piece you talked about was sort of deleveraging, which I think a lot of people argue about is, we’ve been arguing really since 2017 when China first started its financial prudence or financial cleanup efforts, now a decade ago. What is deleveraging in China? Are they truly trying to outright reduce leverage?
Where in the economy are they trying to reduce leverage? Talk to us about what you mean by that concept.
Dinny: The thing that it isn’t, it is not the total amount of debt declining. It’s not having $100 worth of debt yesterday and having $90 worth of debt today. What it’s about is we’re talking about reducing the debt to GDP ratio. So, GDP here is nominal GDP. And that is the important thing because it reflects the capacity of the economy to sustain and service its debt. So, it’s about the size of the debt pile relative to the size of the economy. And Beijing has wanted to bring that down or at the very least stop it from growing for a very long time.
So that cleanup campaign that you mentioned, I mean, that was called explicitly a deleveraging campaign. And they launched at what, a tail end of 2016, really sort of launched, got going in earnest 2017. And at the end of the day, it was more of a de-risking campaign than a de-leveraging campaign. But that said, over the, about an 18 month period over 2017 and ‘18, That debt to GDP ratio did come down. And that’s because they were unraveling shadow banking. And there was a lot of additional debt in the system that was just unnecessary. It was kind of like just layers of debt to kind of obscure what was really going on in the heart of the financial system. And about that time, the debt to GDP ratio was about 240%.
And then it started rising again in late 2018. And in early 2019, the then Premier Li Keqiang, he set a formal target for deleveraging. He said that on a year-on-year basis, what they were aiming for is for credit growth, as measured by total social financing, to roughly, the expansion of credit, as in TSF, to roughly equal the growth of nominal GDP. So those two things would be expanding roughly at the same time. If nominal GDP was growing at 8%, then total social financing would be growing at that pace as well. Now, according to the official data, we did get a period, a short stint of deleveraging in 2020 and 2021.
I mean that was during the pandemic. Credit demand collapsed. But I mean at the time, the GDP data during that period is a little bit sus. I mean, I think there’s a bit of a consensus that the economy probably went into recession in that period but it doesn’t really get borne out by the data. So, whether there was deleveraging then or not, the data says there was. It’s probably fair to assume that there perhaps wasn’t. but what is clear is that the ratio started rising again in a very meaningful way after the housing market peaked in the middle of 2021.
Now, back then, the debt to GDP ratio was about 255%. And by the end of last year, according to the Bank for International Settlements Data, they reckon it had gone up to 300.1%. So that’s an increase of about 45 percentage points. Now, there’s a think tank inside Peking University, which also keeps track of this. It puts out its own numbers. It’s put out more recent data than the BIS. It reckons at the end of the first quarter, the debt to GDP ratio was already at 309%. So, anything over 300% is really high.
I mean, this is a club that includes Japan, Canada, France, the Netherlands, some global financial hubs because they’re doing a lot more sort of financial activity globally relative to the size of their economies, but it’s a pretty small club. And certainly, for developing economies, I mean, you have India’s, Brazil’s, they’re well below 200%. So, over 300% is way, way up there. But as I said, we’ve had this real increase since the housing market peaked. And frankly, that’s perfectly reasonable.
A collapse of economic activity of that scale really requires borrowing to ramp up, usually borrowing by the state. Now, in China, it wasn’t purely by the state. It was the government, and it was also corporations who borrowed and pumped a huge amount of money into manufacturing and industry, particularly around the time, really kicking off just as the pandemic was starting. And that increase in credit, it wasn’t just about making up the shortfall because there was this shortfall of economic activity as investment in property, the property sector contracted. But it was also in aid of achieving Beijing’s growth target, which the economy has consistently been able to do over the last few years.
But here’s the thing. Governments of economies that have experienced a crisis, they often want to pare back their support, their fiscal support, prematurely because they freak out after they see the fiscal burden rising. They start to worry they’re borrowing too much money. They start to worry about overall debt levels. And so, they cut back before the economy can sustain itself. Now, I don’t think Beijing is necessarily freaking out.
I think it’s being a little bit more opportunistic. I think they believe they can… This is a moment in which they can start deleveraging on a sustainable basis because of resurgent inflation and because of strong net export growth.
Andrew: Yeah, thanks for that explanation. I want to get into the inflation and export piece, but I do have to say my piece on the 2017 de-risking campaign. I think you nailed it. That’s the right way to describe it. In fact, I had to train myself for years to call it a de-risking campaign, not a de-leveraging campaign, because every time I call it de-leveraging, people would say, “Ah, they’re not actually de-leveraging. Their total credit’s rising.” I’d be like, yeah, okay. Well, it’s growing more slowly.
And the most important thing I would always point out is as they were de-risking the riskiest, most vulnerable parts of the system, which primarily was the interbank market, that part of the economy, that part of the financial system did deleverage, right? The interbank market, total lending in the interbank market contracted for, I think, 18 months or so. And that was really the riskiest part of the system. So, it was a deleveraging campaign, but just for semantics, probably easier to call it a de-risking campaign.
It was quite successful, and that’s put us in this sort of new world. Sorry, just that point of privilege that I had to touch on. But back to inflation and net exports, talk to us about how those two pieces fit into this deleveraging picture you’re talking about.
Dinny: So the way to think about it is this. As I said, you achieve deleveraging when credit growth is slower than the growth of nominal GDP. So, nominal GDP is real GDP, which is the number that we care about every quarter or so, plus inflation. So, if prices go up, nominal GDP goes up. So, in this current environment, nominal GDP is going up because inflation is back. But credit growth, even at that same moment, credit growth is slowing because credit demand is weak. So, total social financing growth was 7.7% in May year on year.
And that is the slowest pace step ever. So, credit growth is coming down even as nominal GDP is going up because of inflation. So that’s why inflation is such an important part of this picture. The other important condition here is exports. Now, exports are important because deleveraging really requires a growth driver that doesn’t require much debt. The old economic growth model in China, the old property-driven growth model, it was all about debt. You couldn’t drive the economy through property without more and more borrowing.
I mean, people borrowed to buy homes. And the expansion of that borrowing, that was kind of the bedrock of economic growth model. But exports are different. They rely on global demand. It doesn’t require anyone inside of China borrowing more. So, with exports, growth can increase without exporters needing to take on really much additional debt. And so that’s why Beijing feels like it has a moment here to de-lever because it can add growth through exports without taking on much additional debt and inflation is pushing up nominal GDP.
So, if we break down the numbers and what Beijing might be sort of aiming for by the end of the year, it has a real GDP growth target of between 4.5 and 5%. So, if full-year growth comes in at the upper end at 5% and inflation comes in at, I mean, say 2%, then deleveraging starts once total social financing growth gets down to 7%. As I said in May, it was 7%. So, if it gets down to 7, maybe 6.8, 6.9, well, it’s conceivable that that’s the point at which deleveraging begins. Now, of course, if the real economy only grows at 4.5% and inflation is 1%, then total social financing would need to slow to 5.5% by the end of the year, which is far less feasible.
So, the real question is what pace of inflation is likely? I mean, in June, CPI, commercial prices were up 1%, but producer prices were up 4.1%. So, it’s really a bit of a toss-up as to where it’s going to land by year-end.
Andrew: Well, that’s a pretty big call, I mean, especially given how bad the domestic economy is. So, when you think about it, I mean, now doesn’t seem like the time to start deleveraging. You want to deleverage when you’ve got a tailwind to your economy, an upward economic trajectory. So, can you kind of, I don’t know, justify a little bit further or not justify, but expound on why you think they’re not going to kind of try to come in and pump things up?
I mean, I know we haven’t seen much of it in the rhetoric, but typically, even when they’ve been pretty reticent on stimulus or pretty measured on stimulus, when things get this bad, they usually step in with some kind of additional support, as you talked about at the beginning of the podcast. I mean, you know, the debt-to-GDP ratio has been rising for years, right? And they haven’t undertaken a concerted deleveraging campaign. So, just talk to us a little bit more about why you think that term is coming now.
Dinny: Yeah, I think it’s a combination. So, on one level, they’re being opportunistic because of what I said about exports and inflation. They’ve got a moment, they’ve got an opportunity to do something that they’ve always found quite difficult to do. But I think they’ve also got one eye on the long term. And here, the real issue is China’s demography. Because sometime in the next 60 years, the number of retirees in China are going to exceed the working age population.
And I mean, that’s 60 years in the future, but the burden on the state from the transition to that point, as the balance moves against the working-age population, the state is going to need to borrow more and more to fund the healthcare and pension needs of retirees. Now, I’m not sure when Beijing is going to have to sort of start borrowing to meet those obligations, but it’s almost inevitable. And when it does start, borrowing will go on for decades and it will just keep increasing.
So, when that day comes, when Beijing needs to start borrowing to meet the welfare needs of the retirees, it needs as much fiscal space as possible. So, if it starts borrowing when the debt-to-GDP ratio is at 300%, it will have far less runway than if it starts at 250%. But crucially, it’s not about where the level is at the moment. It’s where the level will be if they don’t start deleveraging now, right? Because if the ratio keeps increasing at the pace it has since the housing market peaked, it’ll hit something like 240% within a decade by 2035.
So, something has to give. They either, at the very least, need to stop that ratio increasing as soon as possible because the more it goes up now, the more they really need to pull it back or put it to reverse to kind of prepare for that sort of that demographic decline that’s on the horizon. And that’s far more costly than sort of putting a line under it now and then sort of incrementally pull it back over time. So, something has to give. And, you know, I know I’m talking about total economy-wide debt to GDP ratio. I’m talking about the 300%. And perhaps the more relevant ratio to talk about is the government debt to GDP ratio, because by BIS calculations, it’s about 100%, which, relative to the U.S., is pretty decent. I mean, the US level is 120%.
But the problem is with China, when you’re talking about government debt levels, you’re wading into a morass, because so much of the corporate borrowing is in some way state-related. Most of the corporate debt is either borrowed by state-owned enterprises or it’s borrowed by some local government financing vehicle or some other entity borrowing on behalf of some level of the state. And so, these are implicit liabilities. And we’ve seen over the last few years that implicit liabilities do become explicit in times of financial stress. I mean, we’ve seen this migration of local government debt from LGFEs to local governments. It’s ongoing. We don’t know where the end is. So, looking at that formal debt-to-GDP ratio doesn’t really help as much.
So, I think looking at the overall levels of debt in the economy kind of give us a little bit more of a sense of sort of the potential stresses that the economy could be under and what Beijing is dealing with. Now, the irony of all this is that Beijing’s been aware of this for years. I mean, as I said, they called the cleanup campaign in 2016 a deleveraging campaign. Li Keqiang set that target of you know keeping nominal growth and credit growth in line back in 2019. And this whole new economic growth model, new quality productive forces, which we’ve talked about heaps on this podcast, that new model is, by design, supposed to be debt-light, right?
New quality productive forces is all about generating superior sustainable growth that is driven by productivity gains not by borrowing. So, they’re trying to bake it into the system, they’re trying to overhaul the economy in a way that it will grow on a sustainable basis over the long term with less debt. But because Beijing is still dealing with the fallout of the property bust, we’ve still got this debt rising and rising, and so we’re at this point of what does Beijing do about it? Because on one level, it needs to keep borrowing until the fallout of the crisis is properly dealt with.
But if it does allow debt to continue rising, then it’s really storing up real problems for a not-so-distant future when its hands are tied and it is going to have to ramp up borrowing.
Andrew: Yeah, that makes sense. I mean, truly like trying to not borrow from the future or to maintain your headroom for borrowing later. That makes a lot of sense. I think it all makes sense conceptually, right? I think you made a really compelling case, but I guess the follow-on question for me is what are you seeing that really indicates Beijing has pulled the trigger on deleveraging? And I know you’re going to talk a little bit about credit growth slowing.
But I think the natural sort of skeptic of this argument would say, “Well, credit growth is slowing. Maybe that’s more of the balance sheet recession idea. It’s not about Beijing’s desire to reduce leverage. This is just businesses being in such dire straits that they don’t want to put any more new borrowing on their books. And a lot of this is all outside of Beijing’s control,” right? That would be the bare argument that this is all an imposed reality of years and years of overborrowing and financial expansion. So, tell me what you’re seeing in terms of why you think they’ve pulled the trigger and then respond to that kind of preemptive counter argument.
Dinny: Yeah, I mean, it’s a really good point. I mean, if you looked at the debt to GDP ratio of China’s households, I mean, they’ve been falling really since the peak of the, a bit after the peak of the market in 2021. I mean, households are deleveraging. There is certainly an element of a balance sheet recession going on there, at least with Chinese households. Credit demand is incredibly weak. No one wants to borrow. But of course, I mean, China’s response to these sorts of moments when there is weak credit in the past is always for the state to have stepped in with some sort of measure policy shift that results in an expansion of borrowing. In the late 1990s, when China was dealing with the Asian financial crisis, that’s when we got the housing reforms.
And that sparked off a 20-year boom in housing investment. Global financial crisis; China’s response was a massive expansion in investment in infrastructure and public works. And even when we saw the peak of the housing market in 2021, sparked by government policy changes, the three red lines and whatnot in 2020, the response was a state-initiated and led massive expansion of investment in manufacturing and industrial capacity. So, every time a slowdown in one aspect of the economy was met by the government initiating an expansion of credit somewhere else.
So yeah, you can argue, “Oh, this is just inevitable. This is what happens.” The way that Beijing has dealt with such inevitabilities in the past is to find some way to ramp up credit. And yet it feels like it’s different this time. And we’ve talked about this a little bit in terms of Beijing’s increasing focus on services and trying to get more growth out of low debt parts of the economy. But there’s three things that have really struck me this time, and the first is Beijing allocated less money this year to the consumer trade-in program.
Now, we got these numbers back in March at the NPC. Last year, 300 billion renminbi were allocated to support consumer purchases of big ticket items — cars, furniture, white goods, home appliances, and personal electronics. This year the quota came down to 250 billion. But that decline is far more significant than it looks like at face because the way that this program worked was by pulling forward future demand, right? So, to be able to sustain last year’s consumption at 2025 levels, not even expanding it, Beijing would have had to have increased the quota.
So, to ensure sales stayed at last year’s level, that 300 billion in subsidies they provided needed to have gone up. Now, instead, they reduced it to 250 billion. So, they cut and sales plunged. I mean, you outlined the degree to which sales were down in May at the very beginning of this. I mean, I think auto sales are down 16%. Furniture sales, white goods sales are down double digits as well. So, Beijing made a decision not to throw good money after bad and accept a sharp drop in retail spending in favor of less debt. So that’s the first thing. I mean, that’s a conscious decision like, okay, we’re not going to stimulate the way that we used to.
We’re going to pare back debt because this is not doing what we’d hoped it would. Second thing, SOE remittances, state-owned enterprise remittances. Now, I’m not sure we’ve spoken about this on the podcast, but we’ve written a heap about it. At the end of last year, the central government ramped up the remittances that centrally owned state-owned enterprises are required to pay to the government. So, as a percentage of their profits, it went up from almost all centrally owned state-owned enterprises by between 10 and 15 percentage points.
Now, that’s great for government revenue, right? But it is a meaningful hit to investment. And that’s because SOEs, they use profits as seed money for new projects. Any new investment project requires a certain amount of equity before the firm that’s making the investment can go out and borrow. It’s usually about 20% of the value of the project. So, if SOEs have fewer retained profits, it means that they have less seed money for investments. And so that seed money gets massively leveraged up by borrowing.
And so, it means having the government take a bigger share of SOE profits make meaningfully less investment. We estimate it could reduce fixed asset investment this year by 2.3 percentage points. Now, that’s a back of an envelope calculation, and there’s a whole lot of caveats on that. But the point is that Beijing here has chosen to increase fiscal revenue, over boosting economic through investment. In fact, it’s not even about boosting economic activity. It chose fiscal revenue while knowing that the trade-off would be less economic activity through investment.
So, I think the thing to take away from both of these things is that Beijing realizes that the drag on domestic demand is structural. There are no band-aids that will tide things over until the economy recovers. So, the acknowledgement that you need to keep doubling down on the consumer subsidy program because consumption isn’t going to come back until the underlying problems are fixed. Specifically, the property bust is over, that local government fiscal shortfall is dealt with, and perhaps industrial overcapacity is dealt with.
And so I think that’s where it is, there’s this recognition of like, well, look, borrowing more and more, it’s not fixing anything. All it is, is it’s good money after bad. It’s just about trying to get an extra percentage point of growth, and ultimately it doesn’t really fix anything. And so, yeah, those are my first two, which kind of brings me to the last thing.
Andrew: Well, what’s your last thing?
Dinny: So my last point is it’s less about government policy and it’s more about what the PBOC Pan Gongsheng, PBOC Governor Pan Gongsheng said at the Lujiazui Forum in June. So, you know, Pan has given a speech at this thing annually for the last few years and he usually uses it partly to make some big policy decision announcements, a real shift in the way that the central bank is doing things, and/or to kind of outline a shift in the way government is approaching a particular issue. Last year, it was all about renminbi internationalization. It kind of very much was a signal that Beijing was kind of seeing a significant shift in the way that the world perceived the dollar and kind of saw, okay, this is now a moment for us to do more to promote the RMB’s internationalization.
And in the year, since then, we’ve seen a huge amount of new changes sort of supporting that effort. Now, the really interesting thing, I think, that came out of Pan’s speech this time round were his comments about credit. Now, the first thing he did was that he noted that the severity of the decline in borrowing by property developers and local government financing vehicles since the peak of the property bubble makes it difficult to maintain the pace of growth.
And he said the remaining loans must first fill this decline before they can be considered as incremental growth. And this is, I thought, was really important. He’s like maintaining the previous growth rate for all credit is difficult and unnecessary. And so, rather, this is what he said, rather than trying to maintain high levels of new credit which inevitably leads to some wasteful investment, Pan said this slowing down and improving the quality of loans may become one of the new normal modes of macroeconomic operation.
So, in short, Pan seems to be laying the groundwork for even slower credit growth and acknowledging that the payoff for keeping credit growth high is declining.
Andrew: Well, so, you know, I guess the final question, so you’ve made the case, right? I think, again, convincingly, like this sort of needs to happen. There are structural drivers that the government sees, pushing them to act now. You even have people like Pan Gongsheng, PBOC governor saying like, “This is what we’re trying to do.” But what’s your view in terms of the consequences of all this in terms of short-term economic growth?
Because we have seen, of course, before policymakers enact deleveraging, that was actually the one of the unintended consequences of the last deleveraging campaign was private sector credit growth, private sector borrowing cratered in a way that policymakers didn’t expect. And then they spent years trying to get more credit resources to the SMEs in the small private sector. What do you see as the outcomes, the major outcomes of this effort that you’re arguing is starting to take shape now?
Dinny: Well, I think it’s more of what we’ve already got. So, so far, we’ve got Chinese economists increasingly calling it a K-shaped economy. The up leg of that K is incredibly strong exports. The down leg is domestic demand. And I think domestic demand will stay weak and it will potentially get weaker. It also means export growth is going to become even more important, right? Because the only way for deleveraging to be successful is if China can maintain robust economic growth through robust expansion of net exports.
Now, I think what that means is that that’s going to make it even harder for the EU to get the trade deal they want out of China. I mean, China is going to be even less willing to make concessions. The question is, though, is whether China blinks. So, it might want deleveraging and it might think it’s kind of got this perfect environment in which to do it. But what it means is that weakness in the domestic economy is going to be with us for longer, potentially for quite some time, maybe even forever. And the question is whether ordinary people are willing to tolerate it.
Whether the Chinese public can take the pain, is willing to accept this chronically weak domestic demand environment. So, I think that’s really the question. I think what we’re going to have is weak ongoing domestic demand. Net exports are going to become more and more important. The question is just how long is Beijing willing to endure it?
Andrew: Yeah, that is the key question. And I think that will be the determining factor in terms of how long they’re willing to stick with the policy. And, you know, whether the policy of trying to maintain some level of what we’ll call balance sheet integrity for the economy is worth weaker demand, right? So that you can maintain some headroom for borrowing to support demand in the future. It’s all kind of trying to figure out when you want to kind of play that card to support growth because you’re going to have to do it at some point.
But, Dinny, we got to wrap up. This is all super fascinating. We will see kind of the effects on the economy. We will see how this nascent deleveraging effort plays out. I think you’re early on this. You know, you’ve been kind of looking at this for a while, testing it out. I think hearing people again, like Pan Gongsheng say it, doing our own analysis of various policy tools that have been sort of being deployed. Again, you make the strong case. So, I think it’s a good call. We’ll see kind of how it plays out, whether it’s a good early call.
And I think, like I said, you’ve convinced me. So, I appreciate you walking us through this today. Really fascinating stuff as always, man.
Dinny: No worries, mate. It’s a pleasure as always.
Andrew: All right. Yeah. Good to see you. Good to be back on the pod. And thanks, everybody, for listening. We’ll see you next time, everybody. Bye.
